Video: The Nature of Business: Raising the Standard of Living

Businesses not only have the ability to create wealth and prosperity for their owners, but also for their employees and society at large. In this lesson, you'll learn about how the nature of business can increase the standard of living for all.

Businesses not only have the ability to create wealth and prosperity for their owners, but also for their employees and society at large. In this lesson, you'll learn about how the nature of business can increase the standard of living for all.

Business: Profit and Risk

Meet Phillip. He's just started a business, which is the activities of an individual or organization involving the exchange of goods or services for money. Phillip is certainly not alone in starting a business. However, many people don't decide to start a business because of the risk. Risk is the chance of incurring a type of loss or harm. What's Phillip risking?

You see, Phillip had to invest a significant amount of his personal savings to start his business. He also had to take out a substantial loan from his community bank. Additionally, starting a business is usually a full-time job. Phillip doesn't have the time for another job; he will have to rely upon the income his business produces - and what is left of his savings - to survive. If his business fails, he will lose most of his personal wealth. Most people are unwilling to take the risk. So why does Phillip?

One word: profit. Profit is the economic gain Phillip generates from his business after he pays for all of the costs. Phillip hopes to make more money through his business profits than he ever could working for someone else. Some of the wealthiest people in the world, such as Bill Gates and Warren Buffet, started their own companies, and Phillip hopes to make a fortune, too. And if Phillip is successful, he will also create wealth for other people as well. Here's how.

Your Costs, My Profit

Nearly every business has expenses, which are goods and services needed in order for the business to produce and sell its own goods and services. Let's say that Phillip produces furniture. His expenses include the cost of labor to make the furniture and paying the salespersons to sell it. Additionally, he needs to employ managers and retain the services of lawyers and accountants.

He also has to buy raw materials, such as lumber, metal and fabric, as well as the necessary tools and equipment for manufacturing the furniture. Phillip must pay for freight for the delivery of raw materials and the shipment of his finished products. He must also pay for insurance, water, electricity and other utilities.

Of course, what's an expense to Phillip is someone else's income. Phillip's labor costs are the wages and salaries he pays to his employees. The costs of raw materials are sales for the producers or wholesalers of the raw materials. The freight expenses means revenue for the trucking and rail companies that Phillip uses. And of course, Phillip's sales revenue is someone else's costs, such as businesses and homeowners that decide to purchase furniture from him.

Snowball Effect

Now, let's leave Phillip and take a look at the entire economy to see how business can improve the standard of living for everyone. You can think of standard of living as the level of wealth, material goods, services and comforts available to members of a society.

Remember that every business has expenses, and an expense for one person or business is income for another in a market economy, where we trade goods and services for money. Businesses also have to employ people and pay them a wage or a salary. These employees now have money to pay for goods and services, which require businesses to produce more and employ more people, thereby creating even more demand for goods and services and so on.

You can think of the process as a snowball rolling down a hill, getting larger and larger as the ball continues to add volume. As long as the economy continues to grow, more wealth will be created.

Some will have more wealth than others in this system. Some of the difference in wealth can be attributed to risk taking. People that are willing to take risks have a greater chance at accumulating more wealth. Risks include starting a business or investing in a higher education. Of course, taking a risk doesn't guarantee success. In fact, many businesses fail each year. But if you are successful, the rewards may be high.

Lesson Summary

Let's review what we've learned. While starting and running a business is risky, it does offer the opportunity for wealth generation through profits generated from it. Expenses incurred for goods and services needed by a business to engage in its profit-making activities serve as a source for profit for those who provide the goods and services to the business. As businesses and employees increase their wealth, they tend to spend more, which increases demand for more goods and services, furthering economic growth.

The economic activity generated by business leads to an increase in standard of living. The degree of wealth created by individuals is related, to a degree, to the amount of risk that they are willing to take in the market.

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